ICAI Final Fiancial Reporting - Manual

8/7/2019 ICAI Final Fiancial Reporting - Manual

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The Institute of Chartered Accountants of India

(Set up by an Act of Parliament)

New Delhi

PRACTICE MANUAL

FINANCIAL

REPORTING

FINAL COURSE

PAPER1

VOL. III


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PRACTICE MANUALFinal Course

PAPER :1

FINANCIAL REPORTING

VOLUME-III

BOARD OF STUDIES

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA


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This Practice Manual has been prepared by the faculty of the Board of Studies. The

objective of the study material is to provide teaching material to the students to enablethem to obtain knowledge and skills in the subject. Students should also supplement their

study by reference to the recommended text books. In case students need any

clarifications or have any suggestions to make for further improvement of the material

contained herein, they may write to the Director of Studies.

All care has been taken to provide interpretations and discussions in a manner useful for

the students. However, the Practice Manual has not been specifically discussed by the

Council of the Institute or any of its Committees and the views expressed herein may not

be taken to necessarily represent the views of the Council or any of its Committees.

Permission of the Institute is essential for reproduction of any portion of this material.

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

All rights reserved. No part of this book may be reproduced, stored in retrieval system, or

transmitted, in any form, or by any means, Electronic, Mechanical, photocopying, recording, or

otherwise, without prior permission in writing from the publisher.

Edition : January, 2011

Website : www.icai.org

Department/ : Board of Studies

Committee

E-mail : [email protected]

ISBN No. : 978-81-8441-409-7

Price : ` 150/-

Published by : The Publication Department on behalf of The Institute of CharteredAccountants of India, ICAI Bhawan, Post Box No. 7100, Indraprastha

Marg, New Delhi-110 002, India.

Printed by : Sahitya Bhawan Publications, Hospital Road, Agra 280 003January/2011/20,000 Copies


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AWORD ABOUT PRACTICE MANUAL

The Board of Studies has been instrumental in imparting theoretical education for the students of

Chartered Accountancy Course. The distinctive characteristic of the course i.e., distance

education, has emphasized the need for bridging the gap between the students and the Institute

and for this purpose, the Board of Studies has been providing a variety of educational inputs for the

students. Bringing out a series of subject-wise Practice Manuals is one of the quality services

provided by the Institute. These Practice Manuals are highly useful to the students preparing for

the examinations, since they are able to get answers for all important questions relating to asubject at one place and that too, grouped chapter-wise.

The paper of Financial Reporting in the Final Course concentrates on understanding of the crucial

aspects of preparing and analyzing financial statements. The importance of the subject of financial

reporting is growing over the years due to various factors like liberalization, flow of cross-border

capital, emergence of global corporations and movement towards better corporate governance

practices. Standardization of accounting policies and financial reporting norms are significant

aspects that make the subject more interesting in the recent years. The students are required to

develop understanding of the Accounting Standards and the relevant Guidance Notes and shouldgain ability to apply the provisions contained therein under the given practical situations.

The Practice Manual in the subject of Financial Reporting is divided into ten chapters. It covers a

wide range of practical questions and questions based on practical application of Accounting

Standards and Guidance Notes. Care has been taken to present the chapters in the same

sequence as prescribed in the syllabus to facilitate easy understanding by the students. The

students are expected to cover the entire syllabus and also do the practice on their own while

going through the Practice Manual. The main aim of this Practice Manual is to provide guidance as

to the manner of writing answers in the examination. The main features of this Practice Manual areas follows:

Important definitions, equations, formulae and basic concepts have been given before eachtopic for quick recapitulation.

Compilation of questions from past examinations at Final Level as well as other importantquestions, which would facilitate in thorough understanding of the concepts contained in the

chapters of the study material.

Exercises have been given at the end of each topic for independent practice.The Practice Manual will serve as a useful and handy reference guide while preparing for Final

Examination. Further, it will enhance the understanding about the pattern of questions set and the

manner of answering such questions. It will enable solving the problems in the best possible

manner and guide the students to improve their performance in the examinations. It will also help

them to work upon their grey areas and plan a strategy to tackle theoretical as well as practical

problems.

Happy Reading and Best Wishes!


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CONTENTS

CHAPTER 1: ACCOUNTING STANDARDS AND GUIDANCE NOTES ................1.1 1.59

CHAPTER 2: INTERNATIONAL ACCOUNTING STANDARDS, INTERNATIONAL

FINANCIAL REPORTING STANDARDS, THEIR INTERPRETATIONS

AND US GAAPS AN OVERVIEW...................................................2.1 2.17

CHAPTER 3: CORPORATE FINANCIAL REPORTING.......................................3.1 3.20

CHAPTER 4: ACCOUNTING FOR CORPORATE RESTRUCTURING .................4.1 4.94

CHAPTER 5: CONSOLIDATED FINANCIAL STATEMENTS OF

GROUP COMPANIES..................................................................5.1 5.85

CHAPTER 6: ACCOUNTING AND REPORTING OF FINANCIAL INSTRUMENTS......6.1 6.12

CHAPTER 7: SHARE BASED PAYMENTS .................... ...................... ..............7.1 7.12

CHAPTER 8: FINANCIAL REPORTING FOR FINANCIAL INSTITUTIONS..........8.1 8.15

CHAPTER 9: VALUATION .................. ..................... ..................... ....................9.1 9.53

CHAPTER 10: DEVELOPMENTS IN FINANCIAL REPORTING ......................10.1 10.45


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CHAPTER 1

ACCOUNTING STANDARDS AND GUIDANCENOTES

BASIC CONCEPTS ACCOUNTING STANDARDS

A standard means a generally accepted model or an ideal. Accounting standards are

therefore generally accepted model accounting practices. Unlike GAAPs, accounting

standards are written statements of accounting rules or guidelines or practices for

preparing the uniform financial statements. Accounting. standards are therefore specific

codified rules of accounting to be adopted for treatment of items such as valuation of

fixed assets, valuation of inventories, depreciation, cash flow statement etc. Thepurpose or focus of accounting standards is to convey the same meaning of any

accounting concept to all users of accounting information so that the same meaning in

derived by studying the financial statements. There standards are issued in India by the

Institute of Chartered Accountants of India (ICAI). Thus, Accounting Standards (ASs)

are written policy documents issued by expert accounting body or by government or

other regulatory body covering the aspects of recognition, measurement, presentation

and disclosure of accounting transactions in the financial statements.

GUIDANCE NOTESGuidance Notes are primarily designed to provide guidance to members of ICAI on

matters which may arise in the course of their professional work and on which they

may desire assistance in resolving issues which may pose difficulty. Guidance

Notes are recommendatory in nature. In a situation where certain matters are

covered both by an Accounting Standard and a Guidance Note, issued by the

Institute of Chartered Accountants of India, the Guidance Note or the relevant

portion thereof will be considered as superseded from the date of the relevantAccounting Standard coming into effect, unless otherwise specified in the

Accounting Standard.

Similarly, in a situation where certain matters are covered by a recommendatory

Accounting Standard and subsequently, an Accounting Standard is issued which

also covers those matters, the recommendatory Accounting Standard or the


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relevant portion thereof will be considered as superseded from the date of the new

Accounting Standard coming into effect, unless otherwise specified in the newAccounting Standard.

In a situation where certain matters are covered by a mandatory Accounting

Standard and subsequently, an Accounting Standard is issued which also covers

those matters, the earlier Accounting Standard or the relevant portion thereof will

be considered as superseded from the date of the new Accounting Standard

becoming mandatory, unless otherwise specified in the new Accounting Standard.

Question 1

Write short note on the advantages and disadvantages of setting of Accounting

Standards.

Answer

The Accounting Standards seek to describe the accounting principles, the valuation techniquesand the methods of applying the accounting principles in the preparation and presentation offinancial statements so that they may give a true and fair view. The ostensible purpose of the

standard setting bodies is to promote the dissemination of timely and useful financial information toinvestors and certain other parties having an interest in companies economic performance.

The advantages or benefits of accounting standards may be summarized as follows:

(i) To improve the credibility and reliability of financial statements: The accountingstandards create an environment of confidence amongst the users of the accountinginformation by providing a uniform structure of uniform guidelines which provide credibilityand reliability to the accounting information. In this way the financial statements present a trueand fair view of the financial position and operating results (profit or loss) of a business

organisation.(ii) Comparability: The value of accounting information is enhanced (increased) if it can be

compared easily in the same line of business activity. The comparability is possible only whensame accounting standards are used in the preparation of the financial statements of differentfirms in the same industry. It is a positive step to protect the interests of the users of theaccounting information.

(iii) Benefits to accountants and auditors: The accounting standards provide a basis foruniform accounting practices. In this way there is a less possibility of frauds to be committed

by accountants. There is more transparency in the accounting information. Since theaccounting profession follows the accounting standards without any exception, they arehelpful not only to an accounting entity but to the accountants and auditors too. Any type ofmisinformation can lead to strict action against the accountants as well as auditors.

(iv) Additional disclosures: There are certain areas where important information is not requiredto be disclosed by law. Standards require such additional disclosure such as the methods ofdepreciation used, change of method of method of depreciation etc. which help the users of


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financial statements such as investors, bankers, creditors etc. to take important financialdecisions.

(v) Evaluation of managerial ability: Accounting standards are useful in measuring theefficiency of management regarding the profitability, liquidity, solvency and general progressof the enterprise. In the absence of accounting standards, it would be difficult to evaluate themanagerial efficiency, because there is no basis of comparing the financial results of oneenterprise with that of another. Each enterprise would evolve its own rules or standards to suitits purpose and users of accounting information would fail to get a true and fair view of thefunctioning of an enterprise.

(vi) Helpful to Government: The government officials will find the financial information more

useful for purposes of economic planning, market analysis and tax collections if it is based onestablished accounting standards.

(vii) Reform in accounting theory: The development of accounting standards has been very

helpful in reforming accounting theory and practice in respect of accounting

measurements and financial Information.

However, there are some disadvantages of setting of accounting standards:

(i) Difficult choice: Alternative solutions to certain accounting problems may each havearguments to recommend them. Therefore, the choice between different alternativeaccounting treatments may become difficult.

(ii) Mechanical approach: There may be a trend towards rigidity and away from flexibility inapplying the accounting standards.

(iii) Different from law: Accounting standards cannot override the statute. The standardsare required to be framed within the ambit of prevailing statutes.

Question 2

(a) Briefly indicate the items, which are included in the expression borrowing cost as

explained in AS 16.

(b) Explain the difference between direct and indirect methods of reporting cash flows

from operating activities with reference to Accounting Standard 3( AS 3) revised.

(c) Write short note on Effect of Uncertainties on Revenue Recognition.

Answer

(a) Borrowing costs : Borrowing costs are interest and other costs incurred by anenterprise in connection with the borrowing of funds.

As per para 4 of AS 16 on Borrowing Costs, borrowing costs may include :

(a) interest and commitment charges on bank borrowings and other short-term and

long-term borrowings;

(b) amortisation of discounts or premiums relating to borrowings ;


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(c) amortisation of ancillary costs incurred in connection with the arrangement of

borrowings;

(d) finance charges in respect of assets acquired under finance leases or under other

similar arrangements; and

(e) exchange differences arising from foreign currency borrowings to the extent that

they are regarded as an adjustment to interest costs.

(b) As per para 18 of AS 3 (Revised) on Cash Flow Statements, an enterprise should report

cash flows from operating activities using either:

(a) the direct method whereby major classes of gross cash receipts and gross cash

payments are disclosed; or

(b) the indirect method, whereby net profit or loss is adjusted for the effects of

transactions of a non-cash nature, any deferrals or accruals of past or future

operating cash receipts or payments, and items of income or expense associated

with investing or financing cash flows.

The direct method provides information which may be useful in estimating future

cash flows and which is not available under the indirect method and is, therefore,

considered more appropriate than the indirect method. Under the direct method,


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information about major classes of gross cash receipts and gross cash payments

may be obtained either:

(a) from the accounting records of the enterprise; or

(b) by adjusting sales, cost of sales (interest and similar income and interest

expense and similar charges for a financial enterprise) and other items in the

statement of profit and loss for:

(i) changes during the period in inventories and operating receivables

and payables;

(ii) other non-cash items; and(iii) other items for which the cash effects are investing or financing cash

flows.

Under the indirect method, the net cash flow from operating activities is

determined by adjusting net profit or loss for the effects of:

(a) changes during the period in inventories and operating receivables

and payables;

(b) non-cash items such as depreciation, provisions, deferred taxes, andunrealized foreign exchange gains and losses; and

(c) all other items for which the cash effects are investing or financing

cash flows.

Alternatively, the net cash flow from operating activities may be presented under the

indirect method by showing the operating revenues and expenses, excluding non-

cash items disclosed in the statement of profit and loss and the changes during the

period in inventories and operating receivables and payables.

(c) Effect of Uncertainties on Revenue Recognition

Para 9 of AS 9 on "Revenue Recognition" deals with the effect of uncertainties on

Revenue Recognition. The para states:

1. Recognition of revenue requires that revenue is measurable and at the time of sale

or the rendering of the service it would not be unreasonable to expect ultimate

collection.

2. Where the ability to assess the ultimate collection with reasonable certainty islacking at the time of raising any claim, e.g., for escalation of price, export

incentives, interest etc. revenue recognition is postponed to the extent of

uncertainty involved. In such cases, it may be appropriate to recognise, revenue

only when it is reasonably certain that the ultimate collection will be made. When

there is uncertainty as to ultimate collection, revenue is recognised at the, time of

sale or rendering of service even , though payments are made by instalments.


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3. When the uncertainty relating to collectability arises subsequent to the time of sale

or rendering of the service, it is more appropriate to make a separate provision to

reflect the uncertainty rather than to adjust the amount of revenue originally

recorded.

4. An essential criterion for the recognition of revenue is that the consideration

receivable for the sale of goods, the rendering of services or from the use by others

of enterprise resources is reasonably determinable. When such consideration is not

determinable within reasonable limits; the recognition of revenue is postponed.

5. When recognition of revenue is postponed due to the effect of uncertainties, it is

considered as revenue of the period in which it is properly recognized.

Question 3

Write short notes on:

(a) Impairment of asset and its application to inventory.

(b) Treatment of borrowing costs.

(c) Accounting for investment by a holding company in subsidiaries.

(d) Concept of Materiality.

(e) NACAS.

Answer

(a) The objective of AS 28 Impairment of Assets is to prescribe the procedures that an

enterprise applies to ensure that its assets are carried at no more than their recoverable

amount. An asset is carried at more than its recoverable amount if its carrying amount

exceeds the amount to be recovered through use or sale of the asset. If this is the case,

the asset is described as impaired and this Statement requires the enterprise torecognize an impairment loss.

If carrying amount < = Recoverable amount : Asset is not impaired If carrying amount > Recoverable amount : Asset is impaired

Impairment Loss = Carrying Amount Recoverable Amount

Recoverable amount is the higher of net selling price and its value in use

This standard should be applied in accounting for the impairment of all assets, other than(i) inventories (AS 2, Valuation of Inventories); (ii) assets arising from construction

contracts (AS 7, Accounting for Construction Contracts); (iii) financial assets, including

investments that are included in the scope of AS 13, Accounting for Investments; and (iv)

deferred tax assets (AS 22, Accounting for Taxes on Income). AS 28 does not apply to

inventories, assets arising from construction contracts, deferred tax assets or

investments because other accounting standards applicable to these assets already


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contain specific requirements for recognizing and measuring the impairment related to

these assets.

If carrying amount < = Recoverable amount : Asset is not impaired If carrying amount > Recoverable amount : Asset is impairedImpairment Loss = Carrying Amount Recoverable Amount


(b) According to AS 16,

Meaning of borrowing costs: are interest and other costs incurred by an enterprise in

connection with the borrowing of funds.

What it Includes- Borrowing costs may include: (i) interest and commitment charges on

bank borrowings and other short-term and long-term borrowings; (ii) amortization of

discounts or premiums relating to borrowings; (iii) amortization of ancillary costs incurred

in connection with the arrangement of borrowings; (iv) finance charges in respect of

assets acquired under finance leases or under other similar arrangements; and (v)

exchange differences arising from foreign currency borrowings to the extent that they are

regarded as an adjustment to interest costs.Treatment as per AS 16

When to capitalize- Borrowing costs that are directly attributable to the acquisition,construction or production of a qualifying asset

should be capitalized as part of the

cost of that asset.

The capitalization of borrowing costs as part of the cost of a qualifying asset should

commence when the conditions as mentioned below as specified in AS 16 are

satisfied.

Expenditure for the acquisition, construction or production of a qualifying assetis being incurred

Borrowing costs are being incurred Activities that are necessary to prepare the asset for its intended use or sale

are in progress

When to expense off- Other borrowing costs should be recognized as an expensein the period in which they are incurred.

A qualifying asset is an asset that necessarily takes a substantial period of time1 to get ready

for its intended use or sale.


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(c) Investments by a holding company in the shares of its subsidiary company are normally

considered as long term investments. Indian holding companies show investment in

subsidiary just like any other investment and generally classify it as trade investment. As

per AS 13 Accounting for Investments, investments are classified as long term and

current investments. A current investment is an investment that by its nature is readily

realizable and is intended to be held for more than one year from the date of acquisition.

A long term investment is one that is not a current one.

Costs of investment include besides acquisition charges, expenses such as brokerage,

fees and duties. If an investment is acquired wholly or partly by an issue of shares or

other securities, the acquisition cost is determined by taking the fair value of the

shares/securities issued. If an investment were to be acquired in exchange part or

whole for another asset, the acquisition cost of the investment is determined with

reference to the value of the other asset exchanged. Dividends received out of incomes

earned by a subsidiary before the acquisition of the shares by the holding company and

not treated as income but treated as recovery of cost of the assets (investment made in

the subsidiary). The carrying cost for current investment is the lower of cost or fair/market

value whereas investment in the shares of the subsidiary (treated as long term) is carried

normally at cost.


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(d) Para 17 of AS 1 Disclosure of Accounting Policies, states that financial statements

should disclose all material items, i.e., items the knowledge of which might influence the

decisions of the user of the financial statements. Materiality depends on the size of item

or error judged in the particular circumstances of its omission or misstatement. From a

positive perspective, materiality has to do with the significance of an item or event to

warrant attention in the accounting process. From a negative view point, materiality is

critical because otherwise a great deal of time might be spent on trivial matters in the

accounting process. Individual judgments are required to assess materiality, or to decide

what the appropriate minimum quantitative criteria are to be set for given situations. What

is material to one organization, may not be material for another organization.

For example, a long term investor is interested in the current value of fixed asset like

building, while the banker may not consider it significant for a short-term loan. Similarly a

pair of scissors, ball pens, sharpeners, waste-paper baskets could be used for a number

of years but still it is treated as an expense and not an asset. The omission of paise in

the financial statements is also due to their insignificant effect to the users of the financial

statement in making a decision.

Example

(Requirements as to Profit & Loss Account; Part II of Schedule VI of Companies Act).

In giving break-up of purchases, stocks and turnover, items like spare parts andaccessories, the list of which is too large to be included in the break-up, may be

grouped under suitable headings without quantities, provided all those items, which

in value individually account for 10% or more of the total value of purchases, stocks

or turnover as the case may be, are shown as separate and distinct items with

quantities thereof in the break-up.

Any item under which the expenses exceed 1 per cent of total revenue of thecompany or Rs. 5,000, whichever is higher, are shown as a separate and distinct

item against appropriate account head in the Profit & Loss Account and are not

combined with any other item shown under .Miscellaneous Expenses..

The relevance of information is affected by its materiality. Information is material if its

misstatements (i.e., omission or erroneous statement) could influence the economic

decisions of users taken on the basis of the financial information. Materiality provides a

threshold or cut-off point rather than being a primary qualitative characteristic which the

information must have if it is to be useful.

(e) Under Section 210 A of the Companies Act 1956, the Central Government, by

notification, has constituted a committee to advise the Central Government on the

formulation of accounting policies and accounting standards for adoption by companies


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or class of companies specified under the Act. The Advisory Committee shall consist of

the following members, namely :(i) a Chairperson who shall be a person of eminence well versed in accountancy,

finance, business administration, business law, economics or similar discipline;

(ii) one member each nominated by the Institute of Chartered Accountants of India

constituted under the Chartered Accountants Act, 1949, the Institute of Cost and

Works Accountants of India constituted under the Cost and Works Accountants Act,

1959 and the Institute of Company Secretaries of India constituted under the

Company Secretaries Act, 1980;

(iii) one representative each of the Central Government, Reserve Bank of India ,

Comptroller and Auditor-General of India to be nominated by it;

(iv) a person who holds or has held the office ofprofessor in accountancy, finance or

business management in any university or deemed university;

(v) the Chairman of the Central Board of Direct Taxes constituted under the Central

Boards of Revenue Act, 1963 or his nominee;

(vi) two members to represent the chambers of commerce and industry to be

nominated by the Central Government, and

(vii) one representative of the Securities and Exchange Board of India to be

nominated by it.

The Advisory Committee shall give its recommendations to the Central Government on

such matters of accounting policies and standards and auditing as may be referred to it

for advice from time to time. The members of the Advisory Committee shall hold office for

such terms as may be determined by the Central Government at the time of their

appointment and any vacancy in the membership in the Committee shall be filled by theCentral Government in the same manner as the member whose vacancy occurred was

filled.

Question 4


(a) Reversal of an Impairment Loss.

(b) Timing differences and Permanent differences as per AS 22.

(c) Treatment of refund of Government grants.

Answer

(a) As per AS 28 on Impairment of Assets, an enterprise should assess at each balance

sheet date whether there is any indication that an impairment loss recognised for an

asset in prior accounting periods may no longer exist or may have decreased. If any such

indication exists, the enterprise should estimate the recoverable amount of that asset.


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If carrying amount < = Recoverable amount : Asset is not impaired If carrying amount > Recoverable amount : Asset is impaired

Impairment Loss = Carrying Amount Recoverable Amount


In assessing whether there is any indication that an impairment loss recognized for an

asset in prior accounting periods may no longer exist or may have decreased, an

enterprise should consider, as a minimum, the following indications:

External sources of information

(a) the assets market value has increased significantly during the period;

(b) significant changes with a favourable effect on the enterprise have taken place

during the period, or will take place in the near future, in the technological, market,

economic or legal environment in which the enterprise operates or in the market to

which the asset is dedicated;

(c) market interest rates or other market rates of return on investments have decreased

during the period, and those decreases are likely to affect the discount rate used in

calculating the assets value in use and increase the assets recoverable amountmaterially.

Internal sources of information

(d) significant changes with a favourable effect on the enterprise have taken place

during the period, or are expected to take place in the near future, to the extent to

which, or manner in which, the asset is used or is expected to be used. These

changes include capital expenditure that has been incurred during the period to

improve or enhance an asset in excess of its originally assessed standard of

performance or a commitment to discontinue or restructure the operation to which

the asset belongs; and

(e) evidence is available from internal reporting that indicates that the economic

performance of the asset is, or will be, better than expected.

Reversal is not required if value in use increases in subsequent year merelydue to pattern of cash flow but not due to increase in the earning potential of

the asset

(b) In current practices, Companies In general prepare books of accounts as per CompaniesAct, generating Accounting Profit/Loss and Income Tax Act, generating Taxable

Profit/Loss. Accounting income and taxable income for a period are seldom the same.

Permanent differences are those which arise in one period and do not reverse

subsequently. For e.g., an income exempt from tax or an expense that is not allowable as

a deduction for tax purposes.


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Timing differences are those which arise in one period and are capable of reversal in

one or more subsequent periods. For e.g., Depreciation, Sales Tax , Bonus etc., U/s

43B

(c) As per Para 11 of AS 12 Accounting for Government Grants, government grant that

becomes refundable should be treated as an extraordinary item. The amount refundable

in respect of a government grant related to revenue is applied first against any

unamortized deferred credit remaining in respect of the grant. To the extent that the

amount refundable exceeds any such deferred credit, or where no deferred credit exists,

the amount is charged immediately to profit and loss statement. The amount refundable

in respect of a government grant related to a specific fixed asset is recorded by

increasing the book value of the asset or by reducing the capital reserve or the deferred

income balance, as appropriate, by the amount refundable. In the first alternative, i.e.,where the book value of the asset is increased, depreciation on the revised book value is

provided prospectively over the residual useful life of the asset. Where a grant which is

in the nature of promoters contribution becomes refundable, in part or in full, to the

government on non-fulfillment of some specified conditions, the relevant amount

recoverable by the government is reduced from the capital reserve.

Question 5Write short notes on:

(i) Disclosure of carrying amounts of financial assets and financial liabilities in BalanceSheet

(ii) Financial guarantee contract

(iii) De-recognition of financial liability

Answer

(i) As per AS 32, carrying amounts of each of the following categories, as defined in AS 30,

should be disclosed either on the face of the balance sheet or in the notes:

(a) financial assets at fair value through profit or loss, showing separately (i) those

designated as such upon initial recognition and (ii) those classified as held for

trading in accordance with AS 30;

(b) held-to-maturity investments;

(c) loans and receivables;(d) available-for-sale financial assets;

(e) financial liabilities at fair value through profit or loss, showing separately (i) those

designated as such upon initial recognition and (ii) those classified as held for

trading in accordance with AS 30; and

(f) financial liabilities measured at amortized cost.


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(ii) According to para 8.6 of AS 30, A financial guarantee contract is a contract that

requires the issuer to make specified payments to reimburse the holder for a loss itincurs because a specified debtor fails to make payment when due in accordance

with the original or modified terms of a debt instrument.

(iii) In accordance with paragraphs 43 to 45 of AS 30, An entity should remove a

financial liability (or a part of a financial liability) from its balance sheet when, and

only when, it is extinguished i.e., when the obligation specified in the contract is

discharged or cancelled or expires.

An exchange between an existing borrower and lender of debt instruments with

substantially different terms should be accounted for as an extinguishment of the original

financial liability and the recognition of a new financial liability. Similarly, a substantial

modification of the terms of an existing financial liability or a part of it (whether or not

attributable to the financial difficulty of the debtor) should be accounted for as an

extinguishment of the original financial liability and the recognition of a new financial

liability.

The difference between the carrying amount of a financial liability (or part of a financial

liability) extinguished or transferred to another party and the consideration paid, includingany non-cash assets transferred or liabilities assumed, should be recognized in the

statement of profit and loss.

Question 6

(i) What are the disclosure and presentation requirements of AS 24 for discontinuingoperations?

(ii) What are the different forms of joint ventures? Elucidate the presentation and disclosure

norms of Joint Ventures under AS 27.(iii) Explain the provisions relating to combining of construction contracts.

(iv) Who are related parties under AS 18? What are the related party disclosurerequirements?

(v) Give four examples of activities that do not necessarily satisfy criterion (a) ofparagraph 3 of AS 24, but that might do so in combination with other circumstances.

Answer

(i) An enterprise should include the following information relating to a discontinuing

operation in its financial statements beginning with the financial statements for the period

in which the initial disclosure event (as defined in paragraph 15) occurs:

(a) a description of the discontinuing operation(s);

(b) the business or geographical segment(s) in which it is reported as per AS 17,

Segment Reporting;


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(c) the date and nature of the initial disclosure event;

(d) the date or period in which the discontinuance is expected to be completed if knownor determinable;

(e) the carrying amounts, as of the balance sheet date, of the total assets to be

disposed of and the total liabilities to be settled;

(f) the amounts of revenue and expenses in respect of the ordinary activities

attributable to the discontinuing operation during the current financial reporting

period;

(g) the amount of pre-tax profit or loss from ordinary activities attributable to thediscontinuing operation during the current financial reporting period, and the income

tax expense related thereto; and

(h) the amounts of net cash flows attributable to the operating, investing, and financing

activities of the discontinuing operation during the current financial reporting period.

(ii) Joint ventures take many different forms and structures. This Statement identifies three

broad types jointly controlled operations, jointly controlled assets and jointly controlled

entities which are commonly described as, and meet the definition of, joint ventures.

The following characteristics are common to all joint ventures:

(a) two or more venturers are bound by a contractual arrangement; and

(b) the contractual arrangement establishes joint control.

A venturer should disclose the aggregate amount of the following contingent liabilities,

unless the probability of loss is remote, separately from the amount of other contingent

liabilities:

(a) any contingent liabilities that the venturer has incurred in relation to its interests in

joint ventures and its share in each of the contingent liabilities which have been

incurred jointly with other venturers;

(b) its share of the contingent liabilities of the joint ventures themselves for which it is

contingently liable; and

(c) those contingent liabilities that arise because the venturer is contingently liable for

the liabilities of the other venturers of a joint venture.

A venturer should disclose the aggregate amount of the following commitments in

respect of its interests in joint ventures separately from other commitments:

(a) any capital commitments of the venturer in relation to its interests in joint ventures

and its share in the capital commitments that have been incurred jointly with other

venturers; and

(b) its share of the capital commitments of the joint ventures themselves.


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A venturer should disclose a list of all joint ventures and description of interests in significant

joint ventures. In respect of jointly controlled entities, the venturer should also disclose theproportion of ownership interest, name and country of incorporation or residence.

A venturer should disclose, in its separate financial statements, the aggregate

amounts of each of the assets, liabilities, income and expenses related to its

interests in the jointly controlled entities.

(iii) When a contract covers a number of assets, the construction of each asset should be

treated as a separate construction contract when:

(a) separate proposals have been submitted for each asset;(b) each asset has been subject to separate negotiation and the contractor and

customer have been able to accept or reject that part of the contract relating to each

asset; and

(c) the costs and revenues of each asset can be identified.

A group of contracts, whether with a single customer or with several customers, should

be treated as a single construction contract when:

(a) the group of contracts is negotiated as a single package;

(b) the contracts are so closely interrelated that they are, in effect, part of a single

project with an overall profit margin; and

(c) the contracts are performed concurrently or in a continuous sequence.

(iv) Parties are considered to be related if at any time during the reporting period one party

has the ability to control the other party or exercise significant influence over the other

party in making financial and/or operating decisions.

If there have been transactions between related parties, during the existence of a relatedparty relationship, the reporting enterprise should disclose the following:

(i) the name of the transacting related party;

(ii) a description of the relationship between the parties;

(iii) a description of the nature of transactions;

(iv) volume of the transactions either as an amount or as an appropriate proportion;

(v) any other elements of the related party transactions necessary for an understandingof the financial statements;

(vi) the amounts or appropriate proportions of outstanding items pertaining to related

parties at the balance sheet date and provisions for doubtful debts due from such

parties at that date; and

(vii) amounts written off or written back in the period in respect of debts due from or to

related parties.


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(v) Para 3 of AS 24 Discontinuing Operations explains the criteria for determination of

discontinuing operations. According to Paragraph 9 of AS 24, examples of activities that

do not necessarily satisfy criterion (a) of paragraph 3, but that might do so in combination

with other circumstances, include:

(i) Gradual or evolutionary phasing out of a product line or class of service;

(ii) Discontinuing, even if relatively abruptly, several products within an ongoing line of

business;

(iii) Shifting of some production or marketing activities for a particular line of business

from one location to another; and

(iv) Closing of a facility to achieve productivity improvements or other cost savings.

An example in relation to consolidated financial statements is selling a subsidiary whose

activities are similar to those of the parent or other subsidiaries.

Question 7

Distinguish between :

(i) Integral foreign operation and Non-integral foreign operation.

(ii) Operating lease and Non-operating lease.

Answer

(i)

Meaning

Integral Foreign Operation

It is a foreign operation, the activities

of which are an integral part of those

of the reporting enterprise.

Non-Integral Foreign

(NFO) Operation (NFO)

It is a foreign operation that is not

an integral Foreign Operation.

Business The business of IFO is carried on as if

it were an extension of the reporting

enterprises operations.

The business of NFO is carried on

in a substantially independent

manner by accumulating cash and

other monetary items, incurring

expenses, generating income and

arranging borrowings, in its localcurrency.

Example Sale of goods imported from the

reporting enterprise and remittance of

proceeds to the reporting enterprise.

Production in a foreign country out

of resources available in such

nation independent of the reporting

enterprise.


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Currencies

operated

Generally, IFO carries on business in

a single foreign currency, i.e. of thecountry where it is located.

NFO business may also enter into

transactions in foreign currencies,including transactions in the

reporting currency.

Cash flows

from

operations

Cash flows from operations of the

reporting enterprise are directly and

immediately affected by a change in

the exchange rate between the

reporting currency and the currency in

the country of IFO.

Change in the exchange rate

between the reporting currency

and the local currency, has little or

no direct effect on the present and

future Cash Flows from Operations

of either the NFO or the reporting

enterprise.

Effect of

Change in

Exchange

Rate

Change in the exchange rate affects

the individual monetary items held by

the IFO rather than the reporting

enterprises Net Investment in the

IFO.

Change in the exchange rate

affects the reporting enterprises

net investment in the NFO rather

than the individual monetary and

non-monetary items held by thatNFO.

(ii) Basis of Classification: Leases are classified based on the extent to which risks and

rewards incident to ownership of a leased asset lie with the Lessor or the Lessee.

Risks include the possibilities of losses from idle capacity or technologicalobsolescence and of variations in return due to changing economic conditions.

Rewards may be represented by the expectation of profitable operation over theeconomic life of the asset and of gain from appreciation in value or realisation of

residual value.

As per AS 19 Accounting for Lease, Lease may be of two types: a) Finance Lease b)

Operating Lease.

Finance Lease is a lease which transfers substantially all the risks and rewards

incidental to ownership of an asset to the lessee by the lessor but not the legal

ownership.Operating lease is a lease which does not transfers substantially all the risks and

rewards incidental to ownership. To be precise, it is a lease other than Financial Lease.

Question 8


(i) Graded vesting under an employee stock option plan.


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(ii) Presentation of MAT credit in the financial statements.

Answer

(i) Graded vesting under an employee stock option plan

In case the options/shares granted under an employee stock option plan do not vest on

one date but have graded vesting schedule, total plan should be segregated into different

groups, depending upon the vesting dates. Each of such groups would be having

different vesting period and expected life and, therefore, each vesting date should be

considered as a separate option grant and evaluated and accounted for accordingly. For

example, suppose an employee is granted 100 options which will vest @ 25 options per

year at the end of the third, fourth, fifth and sixth years. In such a case, each tranche of

25 options would be evaluated and accounted for separately.

(ii) Presentation of MAT credit in the financial statements

Balance Sheet

Where a company recognizes MAT credit as an asset on the basis of the considerations

specified in the Guidance Note on Accounting for Credit Available in respect of Minimum

Alternate Tax under the Income Tax Act, 1961, the same should be presented under the

head Loans and Advances since, there being a convincing evidence of realization of theasset, it is of the nature of a pre-paid tax which would be adjusted against the normal

income tax during the specified period. The asset may be reflected as MAT credit

entitlement.

In the year of set-off of credit, the amount of credit availed should be shown as a

deduction from the Provision for Taxation on the liabilities side of the balance sheet.

The unavailed amount of MAT credit entitlement, if any, should continue to be presented

under the head Loans and Advances if it continues to meet the considerations stated in

paragraph 11 of the Guidance Note.

Profit and Loss Account

According to paragraph 6 of Accounting Standards Interpretation (ASI) Accounting for

Taxes on Income in the context of Section 115JB of the Income-tax Act, 1961, issued by

the Institute of Chartered Accountants of India, MAT is the current tax. Accordingly, the

tax expense arising on account of payment of MAT should be charged at the gross

amount, in the normal way, to the profit and loss account in the year of payment of MAT.

In the year in which the MAT credit becomes eligible to be recognized as an asset inaccordance with the recommendations contained in this Guidance Note, the said asset

should be created by way of a credit to the profit and loss account and presented as a

separate line item therein.

Question 9

(a) Discuss the concept of cost v/s fair value with reference to Indian Accounting Standards.


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(b) What are the types of Employees benefits and what is the objective of Introduction of thisStandard i.e. AS-15?

Answer

(a) Cost vs. Fair value

Cost basis: The term cost refers to cost of purchase, costs of conversion on other costsincurred in bringing the goods to its present condition and location. Assets are recorded

at the amount of cash or cash equivalents paid or the fair value of the other consideration

given to acquire them at the time of their acquisition. Liabilities are recorded at the

amount of proceeds received in exchange for the obligation, or in some circumstances

(for example, income taxes), at the amounts of cash or cash equivalents expected to be

paid to satisfy the liability in the normal course of business.

Fair value: Fair value of an asset is the amount at which an enterprise expects toexchange an asset between knowledgeable and willing parties in an arms length

transaction.

Indian Accounting Standards are generally based on historical cost with a very few

exceptions:

AS 2 Valuation of Inventories Inventories are valued at net realizable value (NRV) ifcost of inventories is more than NRV.

AS 10 Accounting for Fixed Assets Items of fixed assets that have been retired from

active use and are held for disposal are stated at net realizable value if their net book

value is more than NRV.

AS 13 Accounting for Investments Current investments are carried at lower of cost

and fair value. The carrying amount of long term investments is reduced to ecognize the

permanent decline in value.AS 15 Employee Benefits The provision for defined benefits is made at fair value of

the obligations.

AS 26 Intangible Assets If an intangible asset is acquired in exchange for shares or

other securities of the reporting enterprise, the asset is recorded at its fair value, or the

fair value of the securities issued, whichever is more clearly evident.

AS 28 Impairment of Assets Provision is made for impairment of assets.

On the other hand IFRS and US GAAPs are more towards fair value. Fair value conceptrequires a lot of estimation and to the extent, it is subjective in nature.

(b) There are four types of employee benefits according to AS 15 (Revised 2005). They are:

(a) short-term employee benefits, such as wages, salaries and social security

contributions (e.g., contribution to an insurance company by an employer to pay for

medical care of its employees), paid annual leave, profit-sharing and bonuses (if

payable within twelve months of the end of the period) and non-monetary benefits


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(such as medical care, housing, cars and free or subsidised goods or services) for

current employees;

(b) post-employment benefits such as gratuity, pension, other retirement benefits, post-

employment life insurance and post-employment medical care;

(c) other long-term employee benefits, including long-service leave or sabbatical leave,

jubilee or other long-service benefits, long-term disability benefits and, if they are

not payable wholly within twelve months after the end of the period, profit-sharing,

bonuses and deferred compensation; and

(d) termination benefits.

Because each category identified in (a) to (d) above has different characteristics,

this Statement establishes separate requirements for each category.

The objective of AS 15 is to prescribe the accounting and disclosure for employee

benefits. The statement requires an enterprise to recognise:

(a) a liability when an employee has provided service in exchange for employee

benefits to be paid in the future; and

(b) an expense when the enterprise consumes the economic benefit arising from

service provided by an employee in exchange for employee benefits.

Question 10

XYZ Ltd., with a turnover of Rs.35 lakhs and borrowings of Rs.10 lakhs during any time in theprevious year, wants to avail the exemptions available in adoption of Accounting Standardsapplicable to companies for the year ended 31.3.2008. Advise the management theexemptions that are available as per Companies (AS) Rules, 2006.

If XYZ is a partnership firm is there any other exemptions additionally available.

Answer

This case deals with the issue of Applicability of Accounting Standards.

Whether AS are applicable or not, in general following test shall be applied:

Applicability of Accounting Standards

First Test:

Are Equity or Debt Securities are Listed or in the process of Listing?

Is this Banking Co. or a Co-operative Bank or Financial Institution or Enterprise carrying on

Insurance Business?

Turnover excluding "other income" is exceeding 50 crores?


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If answer of all of the above is No, this implies that the given enterprise is small and medium sized

enterprise (SME).

Decision:

XYZ Ltd. is a small and medium sized enterprise (SME) company as per Companies (AS)

Rules, 2006. The following relaxations and exemptions are available to XYZ Ltd.

1. AS 3 Cash Flow Statements is not mandatory.

2. AS 17 Segment Reporting is not mandatory.

3. SMEs are exempt from some paragraphs of AS 19 Leases.4. SMEs are exempt from disclosures of diluted EPS (both including and excluding

extraordinary items).

5. SMEs are allowed to measure the value in use on the basis of reasonable estimate

thereof instead of computing the value in use by present value technique under AS 28

Impairment of Assets.

6. SMEs are exempt from disclosure requirements of paragraphs 66 and 67of AS 29

Provisions , Contingent Liabilities and Contingent Assets.7. SMEs are exempt from certain requirements of AS 15 Employee Benefits.

8. Accounting Standards 21, 23, 27 are not applicable to SMEs.

If XYZ is not a company and it will be Partnership Firm as given in the case, then, it will be

treated as a level III enterprise instead of level II enterprise; XYZ Ltd. will be exempt from

requirements of AS 18 Related Party Disclosures and AS 24 Discontinuing Operations.

Question 11

Omega Company Ltd. has to pay delayed cotton clearing charges over and above thenegotiated price for taking delayed delivery of cotton from the Suppliers' Godown. Up to 2008-09, the company has regularly included such charges in the valuation of closing stock. Thisbeing in the nature of interest the company has decided to exclude it from closing stockvaluation for the year 2009-2010. This would result into decrease in profit by Rs. 7.60 lakhs.How would you deal with the following in the annual accounts of a company for the year ended31st March, 2010?

Borrowings exceeded 10 Crores at any time during the year?

Holding or Subsidiary of any of the above?

Second Test:

Is the Turnover (excluding. Other income) exceeding 40 lakhs but not 50 Crores?

Borrowings exceeded 1 Crores but not 10 Crores at any time during the year?

Holding or Subsidiary of any of the above?


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Answer

Para 29 of AS 5 (Revised) Net Profit or Loss for the Period, Prior Period Items and Changesin Accounting Policies states that a change in an accounting policy should be made only if

a. It is required by statute, or

b. for compliance with an accounting standard, or

c. if it is considered that the change would result in a more appropriate presentation of the

financial statements of an enterprise.

Therefore the change in the method of stock valuation is justified in view of the fact that the

change is in line with the recommendations of AS 2 (Revised) Valuation of Inventories andwould result in more appropriate preparation of the financial statements.

Disclosure : As per AS 2, this accounting policy adopted for valuation of inventories including

the cost formulae used should be disclosed in the financial statements in Notes to Accounts.

Also, appropriate disclosure of the change and the amount by which any item in the financial

statements is affected by such change is necessary as per AS 1, AS 2 and AS 5. Therefore,

the under mentioned note should be given in the annual accounts.

"In compliance with the Accounting Standards issued by the ICAl, delayed cotton clearingcharges which are in the nature of interest have been excluded from the valuation of closing

stock unlike preceding years. Had the company continued the accounting practice followed

earlier, the value of closing stock as well as profit before tax for the year would have been

higher by Rs. 7.60 lakhs."

Question 12

Sagar Limited belongs to the engineering industry. The Chief Accountant has prepared the

draft accounts for the year ended 31.03.2010. You are required to advise the company on thefollowing items from the viewpoint of finalization of accounts, taking note of the mandatoryaccounting standards.

(a) The company undertook a contract for building a crane for Rs. 10 lakhs. As on31.03.2010 it incurred a cost of Rs. 1.5 lakhs and expects that there will be Rs. 9 lakhsmore for completing the crane. It has received so far Rs. 1 lakh as progress payment.

(b) The company received an actuarial valuation for the first time for its pension schemewhich revealed a surplus of Rs. 6 lakhs. It wants to spread the same over the next 2

years by reducing the annual contribution to Rs. 2 lakhs instead of Rs. 5 lakhs. Theaverage remaining life of the employees is estimated to be 6 years.

Answer

(a) Para 21 of AS 7 (Revised) Construction Contracts provides that when the outcome of a

construction contract can be estimated reliably, contract revenue and contract costs

associated with the construction contract should be recognized as revenue and expenses


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respectively with reference to the stage of completion of the contract activity at the

reporting date.

Para 35 of AS 7 states that when it is probable that total contract cost will exceed total

contract revenue, the expected losses should be recognized as an expense irrespective

of :

a. Whether or not work has commenced

b. Stage of completion of contract

c. The amount of profit on other contracts which are not treated as a single contract

Thus, when Estimated Contract Costs > Total Contract Revenue

Expected Loss = Work Certified + Work uncertified + estimated cost to complete the

project - Total value of contract

Thus in the given case ,the foreseeable loss of Rs. 50,000 (expected cost Rs. 10.5 lakhs

less contract revenue Rs. 10 lakhs) should be recognized as an expense in the year

ended 31st March, 2010.

The following disclosures should also be given in the financial statements:

(a) the amount of contract revenue recognized as revenue in the period;

(b) the aggregate amount of costs incurred and loss recognized upto the reporting date;

(c) amount of advances received;

(d) amount of retentions; and

(e) gross amount due from/due to customers Amount

(b) According to para 92 of AS 15 (Revised 2005) Employee Benefits, actuarial gains and

losses should be recognized immediately in the statement of profit and loss as income orexpense. Therefore, surplus amount of Rs. 6 lakhs is required to be credited to the profit

and loss statement of the current year.

Question 13

A Ltd. acquired 25% of shares in B Ltd. as on 31.3.2009 for Rs. 3 lakhs. The Balance Sheet of

B Ltd. as on 31.3.2009 is given below:

Rs.Share Capital 5,00,000

Reserves and Surplus 5,00,000

10,00,000

Amount due from/to customers = contract costs + Recognised profits Recognised losses Progress billings = 1.5 + Nil 0.5 1.0 = Nil.


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Fixed Assets 5,00,000

Investments 2,00,000

Current Assets 3,00,000

10,00,000

During the year ended 31.3.2010 the following are the additional information available:

(i) A Ltd. received dividend from B Ltd., for the year ended 31.3.2009 at 40% from theReserves.

(ii) B Ltd., made a profit after tax of Rs. 7 lakhs for the year ended 31.3.2010.(iii) B Ltd., declared a dividend @ 50% for the year ended 31.3.2010 on 30.4.2010.

A Ltd. is preparing Consolidated Financial Statements in accordance with AS 21 for itsvarious subsidiaries. Calculate:

(i) Goodwill if any on acquisition of B Ltd.s shares.

(ii) How A Ltd., will reflect the value of investment in B Ltd., in the Consolidated FinancialStatements?

(iii) How the dividend received from B Ltd. will be shown in the Consolidated FinancialStatements?

Answer

In terms of AS 23 B Ltd. will be considered as an associate company of A Ltd. as shares

acquired represent to more than 20%.

(i) Calculation of Goodwill Rs.in lakhs

Cost of investment 3.00

Less: Share in the value of Equity of B.Ltd.

as at the date of investment

[25% of Rs.10 lakhs (Rs.5 lakhs + Rs. 5 lakhs)] 2.50

Goodwill 0.50

(ii) A Ltd.

Consolidated Profit and Loss Account for the year ended 31st March, 2010Rs. in lakhs

By Share of profits in B Ltd. 1.75

By Dividend received from B Ltd. 0.50

Transfer to investment A/c 0.50 Nil


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(iii) A Ltd.

Consolidated Balance Sheet as on 31.3.2010Rs. in lakhs

Investment in B Ltd.

Share in B Ltd.'s Equity 2.50

Less: Dividend received 0.50

2.00

Share of Profit for year 2009 2010 1.75

3.75

Add: Goodwill 0.50 4.25

Working Notes:

1. Dividend received from B Ltd. amounting to Rs. 0.50 lakhs will be reduced from

investment value in the books of A Ltd. However goodwill will not change.

2. B Ltd. made a profit of Rs. 7 lakhs for the year ended 31st March, 2010. A Ltd.s share in

the profits of Rs. 7 lakhs is Rs. 1.75 lakhs. Investment in B Ltd. will be increased by Rs.1.75 lakhs and consolidated profit and loss account of A Ltd. will be credited with Rs.

1.75 lakhs in the consolidated financial statement of A Ltd.

3. Dividend declared on 30th April, 2010 will not be recognized in the consolidated financial

statements of A Ltd.

Question 14

SM company has taken a Transit Insurance Policy. Suddenly in the year 2009-2010 the

percentage of accident has gone up to 7% and the company wants to recognize insuranceclaim as revenue in 2009-2010 in accordance with relevant Accounting Standards. Do youagree? Explain in brief, as per the relevant Accounting Standards.

Answer

When to Recognize Revenue:

Revenue recognition is mainly concerned with the timing of recognition of revenue in theprofit and loss account.

Where there is no uncertainty as to ultimate collection, revenue is recognised at thetime of sale orrendering of services, as the case may be even though payments are made

by installments.

The amount of revenue is usually determined by agreement between the parties to thetransaction


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It may be appropriate to recognize revenue only when it is reasonably certain that the ultimate

collection will be made.

In the given case, SM company wants to suddenly recognize Insurance claim because it has

increased over the previous year. But, there are uncertainties involved in the settlement

of the claim. Also, the claim does not seem to be in the course of ordinary activity of the

company.

Hence, SM company is not advised to recognize the Insurance claim as revenue.

Question 15

State, how you will deal with the following matters in the accounts of U Ltd. for the year ended31st March, 2010 with reference to Accounting Standards:

(i) The company finds that the stock sheets of 31.3.2009 did not include two pagescontaining details of inventory worth Rs. 14.5 lakhs.

(ii) The company had spent Rs. 45 lakhs for publicity and research expenses on one of itsnew consumer product, which was marketed in the accounting year 2009-2010, butproved to be a failure.

Answer(i) Paragraph 4 of Accounting Standard 5 on Net Profit or Loss for the Period, Prior Period

Items and Changes in Accounting Policies, defines Prior Period items as "income or

expenses which arise in the current period as a result of errors or omissions in the

preparation of the financial statements of one or more prior periods.

Rectification of error in stock valuation is a prior period item vide Para 4 of AS 5. Rs.14.5

lakhs must be added to the opening stock of 1/4/2009. It is also necessary to show Rs.

14.5 lakhs as a prior period adjustment in the Profit and loss Account below the line.

Separate disclosure of this item as a prior period item is required as per Para 15 of AS 5.

(ii) In the given case, the company spent Rs. 45 lakhs for publicity and research of a new

product which was marketed but proved to be a failure. It is clear that in future there will

be no related further revenue/benefit because of the failure of the product. Thus

according to paras 41 to 43 of AS 26 Intangible Assets, the company should charge the

total amount of Rs. 45 lakhs as an expense in the profit and loss account.

Question 16

(a) Venus Ltd. has an asset, which is carried in the Balance Sheet on 31.3.2010 at Rs. 500lakhs. As at that date the value in use is Rs. 400 lakhs and the net selling price is Rs.375 lakhs.

From the above data:

(i) Calculate impairment loss.

(ii) Prepare journal entries for adjustment of impairment loss.


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(iii) Show, how impairment loss will be shown in the Balance Sheet.

(b) Bottom Ltd. entered into a sale deed for its immovable property before the end of theyear. But registration was done with registrar subsequent to Balance Sheet date. Butbefore finalization, is it possible to recognize the sale and the gain at the Balance Sheetdate? Give your view with reasons.

(c) In view of the provisions of Accounting Standard 25 on Interim Financial Reporting, onwhat basis will you calculate, for an interim period, the provision in respect of definedbenefit schemes like pension, gratuity etc. for the employees?

Answer

(a) (i) Recoverable amount is higher of value in use Rs. 400 lakhs and net selling price

Rs. 375 lakhs.

Recoverable amount = Rs. 400 lakhs

Impairment loss = Carried Amount Recoverable amount

= Rs. 500 lakhs Rs. 400 lakhs = Rs. 100 lakhs.

(ii) Journal Entries

Particulars Dr. Cr.

Amount Amount

Rs. in lakhs Rs. in lakhs

(i) Impairment loss account Dr. 100

To Asset 100

(Being the entry for accountingimpairment loss)

(ii) Profit and loss account Dr. 100To Impairment loss 100

(Being the entry to transferimpairment loss to profit and lossaccount)

(iii) Balance Sheet of Venus Ltd. as on 31.3.2010

Rs. in lakhs

Asset less depreciation 500Less: Impairment loss 100

400

(b) Yes, both sales and gain of Bottom Ltd. should be recognized. In accordance with AS 9,

at the Balance Sheet date and what was pending was merely a formality to register the

deed. It is clear that significant risk and rewards of ownership had passed before the


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balance sheet date. Further the registration post the balance sheet date confirms the

condition of sale at the balance sheet date as per AS 4.

(c) Accounting Standard 25 suggests that provision in respect of defined benefit schemes

like pension and gratuity for an interim period should be calculated based on the year-to-

date basis by using the actuarially determined rates at the end of the prior financial year,

adjusted for significant market fluctuations since that time and for significant curtailments,

settlements or other significant one-time events.

Question 17

In May, 2009 Speed Ltd. took a bank loan to be used specifically for the construction of a newfactory building. The construction was completed in January, 2010 and the building was put toits use immediately thereafter. Interest on the actual amount used for construction of thebuilding till its completion was Rs. 18 lakhs, whereas the total interest payable to the bank onthe loan for the period till 31st March, 2010 amounted to Rs. 25 lakhs. Can Rs. 25 lakhs betreated as part of the cost of factory building and thus be capitalized on the plea that the loanwas specifically taken for the construction of factory building?

Answer

AS 16 clearly states that capitalization of borrowing costs should cease when substantially allthe activities necessary to prepare the qualifying asset for its intended use are completed.

Therefore, interest on the amount that has been used for the construction of the building upto

the date of completion (January, 2010) i.e. Rs. 18 lakhs alone can be capitalized. It cannot be

extended to Rs. 25 lakhs.

Question 18

The Chief Accountant of Sports Ltd. gives the following data regarding its six segments:

Rs. In lakhs

Particulars M N O P Q R Total

Segment Assets 40 80 30 20 20 10 200

Segment Results 50 -190 10 10 -10 30 -100

Segment Revenue 300 620 80 60 80 60 1,200

The Chief accountant is of the opinion that segments M and N alone should be reported. Ishe justified in his view? Discuss.

Answer

As per para 27 of AS 17 Segment Reporting, a business segment or geographical segment

should be identified as a reportable segment if:

(i) Its revenue from sales to external customers and from other transactions with other

segments is 10% or more of the total revenue- external and internal of all segments; or


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(ii) Its segment result whether profit or loss is 10% or more of:

(1) The combined result of all segments in profit; or(2) The combined result of all segments in loss, whichever is greater in absolute

amount; or

(iii) Its segment assets are 10% or more of the total assets of all segments.

If the total external revenue attributable to reportable segments constitutes less than 75%

of total enterprise revenue, additional segments should be identified as reportable

segments even if they do not meet the 10% thresholds until atleast 75% of total

enterprise revenue is included in reportable segments.(a) On the basis of turnover criteria segments M and N are reportable segments.

(b) On the basis of the result criteria, segments M, N and R are reportable segments

(since their results in absolute amount is 10% or more of Rs.200 lakhs).

(c) On the basis of asset criteria, all segments except R are reportable segments.

Since all the segments are covered in atleast one of the above criteria all segments have to be

reported upon in accordance with Accounting Standard (AS) 17. Hence, the opinion of chief

accountant is wrong.

Question 19

Victory Ltd. purchased goods on credit from Lucky Ltd. for Rs.250 crores for export. Theexport order was cancelled. Victory Ltd. decided to sell the same goods in the local marketwith a price discount. Lucky Ltd. was requested to offer a price discount of 15%. The ChiefAccountant of Lucky Ltd. wants to adjust the sales figure to the extent of the discountrequested by Victory Ltd. Discuss whether this treatment is justified.

Answer

Lucky Ltd. had sold goods to Victory Ltd on credit worth for Rs.250 crores and the sale was

completed in all respects. Victory Ltds decision to sell the same in the domestic market at a

discount does not affect the amount recorded as sales by Lucky Ltd. The price discount of 15%

offered by Lucky Ltd. after request of Victory Ltd. was not in the nature of a discount given during

the ordinary course of trade because otherwise the same would have been given at the time of

sale itself. Now, as far Lucky Ltd is concerned, there appears to be an uncertainty relating to the

collectability of the debt, which has arisen subsequent to the time of sale therefore, it would be

appropriate to make a separate provision to reflect the uncertainty relating to collectability rather

than to adjust the amount of revenue originally recorded. Therefore, such discount should be

written off to the profit and loss account and not shown as deduction from the sales figure.

Question 20

(a) A company had imported raw materials worth US Dollars 6,00,000 on 5th January, 2010,when the exchange rate was Rs.43 per US Dollar. The company had recorded the


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transaction in the books at the above mentioned rate. The payment for the importtransaction was made on 5th April, 2010 when the exchange rate was Rs.47 per USDollar. However, on 31st March, 2010, the rate of exchange was Rs.48 per US Dollar.The company passed an entry on 31st March, 2010 adjusting the cost of raw materialsconsumed for the difference between Rs.47 and Rs.43 per US Dollar.

In the background of the relevant accounting standard, is the companys accountingtreatment correct? Discuss.

(b) A private limited company manufacturing fancy terry towels had valued its closing stockof inventories of finished goods at the realisable value, inclusive of profit and the export

cash incentives. Firm contracts had been received and goods were packed for export,but the ownership in these goods had not been transferred to the foreign buyers.

Comment on the valuation of the stocks by the company.

Answer

(a) As per AS 11 (revised 2003), The Effects of Changes in Foreign Exchange Rates,

monetary items denominated in a foreign currency should be reported using the closing

rate at each balance sheet date. The effect of exchange difference should be taken into

profit and loss account. Sundry creditors is a monetary item, hence should be valued atthe closing rate i.e, Rs.48 at 31st March, 2010 irrespective of the payment for the same

subsequently at lower rate in the next financial year. The difference of Rs.5 (48-43) per

US dollar should be shown as an exchange loss in the profit and loss account for the

year ended 31st March, 2010 and is not to be adjusted against the cost of raw- materials.

In the subsequent year, the company would record an exchange gain of Re.1 per US

dollar, i.e., the difference between Rs.48 and Rs.47 per Us dollar. Hence, the accounting

treatment adopted by the company is incorrect.

(b) Accounting Standard 2 Valuation of Inventories states that inventories should be valuedat lower of historical cost and net realizable value. AS 9 on Revenue Recognition

states, at certain stages in specific industries, such as when agricultural crops have

been harvested or mineral ores have been extracted, performance may be substantially

complete prior to the execution of the transaction generating revenue. In such cases,

when sale is assured under forward contract or a government guarantee or when market

exists and there is a negligible risk of failure to sell, the goods invoiced are often valued

at Net-realisable value.

Terry Towels do not fall in the category of agricultural crops or mineral ores. Accordingly,taking into account the facts stated, the closing stock of finished goods (Fancy terry

towel) should have been valued at lower of cost and net-realisable value and not at net

realisable value. Further, export incentives are recorded only in the year the export sale

takes place. Therefore, the policy adopted by the company for valuing its closing stock of

inventories of finished goods is not correct.


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Question 21

(a) A company with a turnover of Rs.250 crores and an annual advertising budget of Rs.2crore had taken up the marketing of a new product. It was estimated that the companywould have a turnover of Rs. 25 crores from the new product. The company had debitedto its Profit and Loss account the total expenditure of Rs.2 crore incurred on extensivespecial initial advertisement campaign for the new product.

Is the procedure adopted by the company correct?

(b) A company deals in petroleum products. The sale price of petrol is fixed by thegovernment. After the Balance Sheet date, but before the finalisation of the companysaccounts, the government unexpectedly increased the price retrospectively. Can thecompany account for additional revenue at the close of the year? Discuss.

(c) Mohur Ltd. has equity capital of Rs.40,00,000 consisting of fully paid equity shares ofRs.10 each. The net profit for the year 2009-10 was Rs.60,00,000. It has also issued36,000, 10% convertible debentures of Rs.50 each. Each debenture is convertible intofive equity shares. The tax rate applicable is 30%. Compute the diluted earnings.

Answer

(a) According to paras 55 and 56 of AS 26 Intangible Assets, expenditure on an intangible

item should be recognised as an expense when it is incurret unless it forms part of the

cost of an intangible asset.

In the given case, advertisement expenditure of Rs. 2 crores had been taken up for the

marketing of a new product which may provide future economic benefits to an enterprise

by having a turnover of Rs.25 crores. Here, no intangible asset or other asset is acquired

or created that can be recognised. Therefore, the accounting treatment by the company

of debiting the entire advertising expenditure of Rs.2 crores to the Profit and Loss

account of the year is correct.

(b) According to para 8 of AS 4 (Revised 1995), the unexpected increase in sale price of

petrol by the government after the balance sheet date cannot be regarded as an event

occurring after the Balance Sheet date, which requires an adjustment at the Balance

Sheet date, since it does not represent a condition present at the balance sheet date.

The revenue should be recognized only in the subsequent year with proper disclosures.

The retrospective increase in the petrol price should not be considered as a prior

period item, as per AS 5, because there was no error in the preparation of previous

periods financial statements.

(c) Interest on Debentures @ 10% for the year36,00050

100

10

= Rs.1,80,000

Tax on interest @ 30% = Rs.54,000


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Diluted Earnings (Adjusted net profit) = (60,00,000 + 1,80,000-54,000)

= Rs. 61,26,000

Question 22

(a) During the course of the last three years, a company owning and operating Helicopterslost four Helicopters. The company Accountant felt that after the crash, the maintenanceprovision created in respect of the respective helicopters was no longer required, andproposed to write back to the Profit and Loss account as a prior period item.

Is the Companys proposed accounting treatment correct? Discuss.

(b) Mr. X as a contractor has just entered into a contract with a local municipal body forbuilding a flyover. As per the contract terms, X will receive an additional Rs.2 crore if theconstruction of the flyover were to be finished within a period of two years of thecommencement of the contract. Mr. X wants to recognize this revenue since in the pasthe has been able to meet similar targets very easily.

Is X correct in his proposal? Discuss.

(c) A Company is in the process of setting up a production line for manufacturing a new

product. Based on trial runs conducted by the company, it was noticed that theproduction lines output was not of the desired quality. However, company has taken adecision to manufacture and sell the sub-standard product over the next one year due tothe huge investment involved.

In the background of the relevant accounting standard, advise the company on the cut-offdate for capitalization of the project cost.

(d) A Company has an inter-segment transfer pricing policy of charging at cost less 10%.The market prices are generally 25% above cost. Is the policy adopted by the company

correct?

Answer

(a) The balance amount of maintenance provision written back to profit and loss account, no

longer required due to crash of the helicopters, is not a prior period item because there

was no error in the preparation of previous periods financial statements. The term prior

period items, as defined in AS 5 (revised) Net Profit or Loss for the Period, Prior Period

Items and Changes In Accounting Policies, refer only to income or expenses which arise

in the current period as a result of errors or omissions in the preparation of the financialstatements of one or more prior periods. As per paragraph 8 of AS 5, extraordinary items

should be disclosed in the statement of profit and loss as a part of net profit or loss for

the period. The nature and the amount of each extraordinary item should be separately

disclosed in the statement of profit and loss in a manner that its impact on current profit

or loss can be perceived. The amount so written-back (If material) should be disclosed as

an extraordinary item as per AS 5.


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(b) According to para 14 of AS 7 (Revised) Construction Contracts, incentive payments are

additional amounts payable to the contractor if specified performance standards are met

or exceeded. For example, a contract may allow for an incentive payment to the

contractor for early completion of the contract. Incentive payments are included in

contract revenue when: (i) the contract is sufficiently advanced that it is probable that the

specified performance standards will be met or exceeded; and (ii) the amount of the

incentive payment can be measured reliably. In the given problem, the contract has not

even begun and hence the contractor (Mr. X) should not recognize any revenue of this

contract.

(c) As per provisions of AS 10 Accounting for Fixed Assets, expenditure incurred on start-

up and commissioning of the project, including the expenditure incurred on test runs and

experimental production, is usually capitalized as an indirect element of the construction

cost. However, the expenditure incurred after the plant has begun commercial production

i.e., production intended for sale or captive consumption, is not capitalized and is treatedas revenue expenditure even though the contract may stipulate that the plant will not be

finally taken over until after the satisfactory completion of the guarantee period. In the

present case, the company did stop production even if the output was not of the desired

quality, and continued the sub-standard production due to huge investment involved in

the project. Capitalization should cease at the end of the trial run, since the cut-off datewould be the date when the trial run was completed.

(d) AS 17 Segment Reporting requires that inter-segment transfers should be

Documents

ICAI Final Fiancial Reporting - Manual